Gillmor Gang

Disruptive innovations all have at least one characteristic in common. They percolate through an economy seeking a best use scenario because it’s the market, and not the inventor, that makes a determination of utility. Cryptocurrency is undergoing such a moment and it may be hampered by use of “currency.” Is it a currency or a security?

Cryptocurrencies have proliferated like rabbits. One study concludes there are 1,448 of them and the number is growing. https://coinmarketcap.com/all/views/all/ In a world of central banking, reserve currencies and sophisticated trading markets, is there a place for this asset category? There is little doubt that cryptocurrency is a disruptive innovation but its existence begs the question of what’s being disrupted.

Some advocates say that cryptocurrencies are a new form of currency that skirts the limitations of government-controlled currencies by avoiding regulations. But those principles also represent hard-won knowledge about how markets work and how best to control inflation and ward off the worst effects of recession. Also, there is little of value backing up cryptocurrencies which makes them pawns in a confidence game at worse or just another fiat currency at best. But other fiat currencies, like the dollar, are backed by “the full faith and credit” of the nation state and its ability to tax or otherwise use the assets under its control to support the value of currency.

Others look at this asset class more as investments akin to securities that can fluctuate on open markets. It’s possible cryptocurrencies are both or neither but the current rollercoaster ride seems tailor-made for figuring it out.

It’s possible we may have to get used to a duality of uses for this asset class. Sometimes cryptocurrencies act like currencies while other times they act like securities. As a metaphor, this is reminiscent of the quantum duality of light—it can be described as an energy wave (electro-magnetic radiation) as well as a particle of zero mass (the photon). We routinely use the best definition for a circumstance. Or consider silicon, a “semi-conductor” a material that can act as either a conductor or a resistor depending on the electric current flowing through it.

Currency and banking

As it stands cryptocurrencies are not very good currencies. Their value changes depending on the whims of the market and there is no central banking facility to maintain liquidity in times of financial stress or to manage inflation and the money supply. Cryptocurrency can be used in transactions the same way that Monopoly money can be—under very specific circumstances and so long as both parties agree.

As we’ve recently seen, cryptocurrencies are not great stores of value either, because their value can fluctuate significantly within a day or a week. Stability in a currency is vital for without it, people would be resistant to spending it if they felt that the price was likely to rise or they would be resistant to own it if they expected it to inflate and become valueless in the near term.

Securities and finance

Markets for cryptocurrencies act more like stock exchanges and we’ve seen wild swings in recent trading of Bitcoin, the grand daddy of the group. So cryptocurrency seems to be a better fit as a security whose value is expected to fluctuate.

Fluctuation can be a good thing. I was a guest on the streaming show, “The Gillmor Gang” last week when the discussion turned to cryptocurrency. Another guest, Keith Teare, a venture capitalist involved with cryptocurrencies, described his use of crypto to raise capital for his venture funds. His method avoids the typical funding process of raising big contributions from a small number of investors. Instead it can raise any amount from average investors by selling cryptocurrency. Tears’ description and explanation begins at the 46-minute mark and it’s well worth the time.

Unlike a crowdsourcing model in which people invest money at face value, say $100, Teare’s model generates heavily discounted cryptocurrency and sells it to investors while giving the hard currency raised to startups. For example, he might issue a crypto dollar with a value of one cent based on the value of the startups in the portfolio. As the startups progress through time the value of the currency increases (or not). At some point your investment is either worthless in which case you’ve lost one cent on the dollar or it’s worth potentially more than the face value of the cryptocurrency.

Generally, if you invest this way in a portfolio and not an individual company the chances of all portfolio companies going south is small and the odds of your investment becoming worth more than one cent on the dollar in the future is reasonable. But wary investors will note that this scheme operates outside of the rules of the Securities and Exchange Commission (SEC) in the US and similar bodies elsewhere. So, sadly, there’s room for the unscrupulous to game the system.

Nevertheless, in this process the cryptocurrency acts more like a stock or a bond or possibly some as yet unnamed derivative that combines aspects of each. The cryptocurrency is far from being a legal tender for all debts but in the right situation it’s a good fit. In this model it’s easy to see how cryptocurrencies could proliferate, each securing part of a transaction such as a venture fund, in the same way that bonds are issued for a particular debt offering. So at the end of the day, the cryptocurrency acts both as a security and as a currency, that’s the duality.

When crypto currency is used for discrete commerce or as an investment it works reasonably well. Teare’s use of crypto is a good example of using it as a form of a bond. Like a bond, it is heavily discounted initially and its value fluctuates but it still generates value in a kind of interest payment.

Analysis

Cryptocurrency is more likely to be a disruptive innovation in finance but not one in banking and currency. It’s too volatile to act as store of value but might well have a place as a token of debt or more broadly as a security such as a bond with some stock attributes.

As a currency cryptocurrencies lack the necessary central banking infrastructure so it will be hard gaining traction there. The exception is that convertibility to dollars, Euros, or another established currency enables a cryptocurrency to access part of the beneficial aspects of conventional currencies such as the liquidity provided by central banks.

So as long as there are real currencies and the central banks needed to keep them functioning, it’s difficult to see how they replace conventional currencies. But it’s also hard to see how they harm functioning economies unless they all evaporate. This is an area of concern for anyone who appreciates how involved Russia and China are in cryptocurrencies. A hostile power intent on doing harm to the global economy could, in theory, flood the market is bogus cryptocurrency inflating them and rendering them useless and valueless.

Proponents of cryptocurrencies point to blockchain technology, a distributed ledger system designed to make it virtually impossible to carry off such a scheme. Two years ago one might have said the same about social media and democratic systems.

“The Bitcoin bubble may ultimately turn out to be a distraction from the true significance of the blockchain.”

and blockchain could ultimately be the tail wagging the dog in all this.

My two cents worth

It is entirely possible that the disruptive innovation of cryptocurrency has not found its niche yet. If the market for cryptocurrency tanks, its use as a neo-currency will be over. As a way to raise money and reward investors crypto might face better odds especially if it can find its niche.

Here’s an idea.

The conventional economy seems reluctant to embrace the infrastructure needs of a world in crisis over climate change. Cryptocurrency could turn out to be the financing arm of a movement that builds more renewable power generation and distribution or that finances new ecosystem service provisioning. For example, increasing the amount of fresh water available to support populations in arid regions is such an ecosystem service. So is supporting a Green Race that promotes more photosynthesis planet-wide in an effort to reabsorb atmospheric carbon.

As we said at the start, inventors create products but the marketplace is responsible for defining best uses. In this, the experiment in cryptocurrency is not over by a long shot.

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Beagle Research Group, LLC is a CRM analyst firm founded in 2004. We perform market research for vendors and advise end users in CRM selection, deployment and use. We also publish a steady stream of analysis on many of the industry’s most popular topics as well as emerging trends. For example, one of our core pursuits is researching emerging companies to understand current innovation trends. This research informs the advice we give our clients and readers.